Peak Oil Review - May 19th, 2008

1. Production and Prices

In volatile trading, oil prices set a new record just shy of $128 a barrel last week before closing at a new high of $126.29 a barrel. Gasoline and heating oil futures also closed at new highs. Despite a new IEA monthly report forecasting that high prices will further lower demand in the OECD countries, worldwide demand led by China and the Middle East is still projected to grow by 1 million b/d during 2008. The IEA says world oil production fell by 400,000 b/d in April, largely caused by lower Russian output, the strike in the UK and pipeline sabotage in Nigeria. The EIA says US crude imports in March fell by 9.3 percent to an average of 9.38 million b/d.

While the IEA is still forecasting that production will meet demand for the rest of the year, the Agency notes there is a mismatch between spare world productive capacity of 2.3 million b/d, which consists largely of heavy oil, and the refining capacity to make use of this oil. During the week Iran said it may cut back because it is unable to sell all of its heavy oil production.

Observers are noting that the tight distillate supplies may be responsible for the current run-up in prices. Stockpiles in the developed countries are 6.7 percent lower than last year; however the US stock of distillates increased for the first time in many weeks as refiners concentrated on production of the more profitable diesel and heating oil.

There were a number of other developments affecting oil prices during the week. Goldman Sachs issued a forecast that crude will reach $135 a barrel in the third quarter of 2008 and $145 in the fourth quarter. President Bush, under pressure from a vote in Congress, halted additions to the US Strategic Petroleum Reserve and the Saudi’s announced that they would increase production by 300,000 b/d to 9.45 million b/d during June in order meet demand from US customers. While Goldman’s forecast caused a stir, stopping additions to the SPR and the Saudi increase were widely dismissed as too little to affect prices.

2. China

Although the Sichuan earthquake seems unlikely to set back China’s economic growth by very much, the disaster may have a noticeable impact on China’s energy supply and imports of coal and oil. The area subjected to the quake produces about 22 percent of China’s natural gas supplies and contains many coal mines and hydro-electric dams which generated about 62 percent of the province’s total electricity production. Many of the 396 power stations on the river system and their dams were damaged. Several major reservoirs are being drained to prevent their dams from failing. Beijing ordered coal mines, oil and gas wells, and chemical plants affected by the quake to shut down until the situation could be assessed. Twenty-two coal mines in Sichuan, Chongqing and Gansu provinces were affected by the quake.

Loss of significant amounts of natural gas, coal, and electricity production for an indefinite period suggests that China will have to step up imports of coal and oil products. Already some 700,000 barrels of emergency fuel supplies have been dispatched to the area.

Prior to the earthquake, China’s crude and oil products imports were already increasing rapidly. Crude imports in the first 4 months of 2008 were up 9.8 percent over 2007 to support an increase in industrial production of 15.7 percent in April. Diesel imports in April rose to 520,000 tons from 30,000 tons a year earlier and 490,000 tons in March. Traders say that China is planning to import still more oil in May and June to prepare for the Olympics and to support recovery from the earthquake. No let-up to Chinese demand for oil is yet in sight, suggesting that world prices will continue to move higher during the summer.

3. Iran's Production Cut

The oil markets were shaken last week by a statement from an unidentified Iranian official that Iran’s oil output would be cut by between 400,000 and one million b/d beginning next month. The report was given credence by other reports that Tehran had chartered large tankers to store up to 30 million barrels of crude in the Persian Gulf and that these tankers were nearly full.

The report was followed by a statement by Iran’s oil Minster and later confirmed by President Ahmadinejad that the matter of cutting production was still under review and that no decision had been taken as yet.

The problem is a growing mismatch between the proportion of heavy sour crudes available for sale on world markets and the capability of refineries to turn this crude into profitable products. As production of North Sea and Nigerian light crudes slows, the share of heavy crudes is increasing to the point where there is no capacity to refine the heavy crude at a profit. When refineries install processing units called “cokers,” which cost hundreds of millions of dollars, they are able to take asphalt-like “residuals” and break them down into valuable products. While light oils may contain only 5 percent residuals, heavy oils may approach 30 percent, thus light crudes tend to sell for less than heavy oils. Recently the price discount for Iran’s heavy crude as compared to the benchmark West Texas Intermediate has quadrupled to $11 a barrel vs. $2.65 last year.

Iranian officials and refiners both say the problem is one of price and quality. Iran is refusing to cut the prices further and refiners are saying this crude is a nightmare to refine and that if the Tehran wants to get rid of it they will have to lower the price. Iran had a similar problem in 2006 and eventually sold the crude to Shell and India at a steep discount.

These problems are unlikely to be solved soon. The addition of cokers and hydrocrackers is not only expensive but takes years to accomplish. In the meantime, Iran’s inability to sell its oil except at unacceptably large discounts may slow global production.

4. Energy Briefs

Aramco and Conoco said they will proceed with plans to build a 400,000 barrel-per-day refinery in Yanbu, Saudi Arabia, even as costs for new refining facilities soar. (5/17, #7)

Azerbaijan produced an average of 940,500 barrels a day of oil in April, up 0.9% on the previous month. (5/13, #7)

Eni and the partners developing the Kashagan oil field may delay production by as much as two years, the fourth postponement at the 7 billion to 9 billion-barrel discovery to date. The start of commercial output may not occur until 2012 or 2013. The government threatened new financial penalties for this delay. (5/12, #5; 5/13, #8)

A planned 500,000-barrel-a-day refinery to be built in Brazil by Petrobras will cost between $8 billion and $10 billion. A second smaller refinery, to process 200,000 b/day, would cost $5 billion. Construction on both would start in 2009. (5/17, #10)

Petrobras leased about 80 percent of the world's deepest-drilling offshore rigs to explore its new deepwater finds. The world has 21 such vessels. Other oil companies probably will pay $50,000 more per day to lease deepwater rigs (likely over $600,000 per day) during the next three years because Petrobras has already contracted for so much of the worldwide fleet. (5/15, #9)

Petrobras will start a long-term production test at its giant Tupi field in March 2009. The 2-3 month test will produce 30,000 barrels a day from the field from three wells. The company already has a platform available for the long-term test, and it is searching for a rig for a pilot production of 100,000 barrels of oil and 4 million cubic meters of gas a day at the field beginning in December 2010. (5/14, #9)

Indonesia, facing widespread protests over planned fuel price hikes, aims to lower its costs by reducing expensive imported oil and increasing the country's production to 1.2-1.5 million b/d by 2010 from the current 920,000 b/d. (5/16, #10) [Editor’s note: Indonesian production has declined 30% since its peak production in 1994; the relatively steady decline makes more than a short-term reversal unlikely.]

Norway trimmed its 2008 oil production forecast to 2.4 million barrels per day from a previous projection of 2.5 million bpd. (5/16, #15) [Editor’s note: Norway’s production peaked at 3.4 million barrels/day in 2001; production has since declined 30%.]

Venezuela's overall oil production stood at 2.32 million barrels a day in April, a 4.5% drop from the beginning of the year, according to the IEA. The government’s new windfall oil profits tax will delay a planned expansion of Shell’s operations in Venezuela.(5/15, #10; 5/14,#11)

Venezuela announced plans to ship oil to Portugal in exchange for food products and other goods that have been running short in the South American country. (5/14, #10)

Coal for delivery in northwest Europe rose to a record $152.25 per metric ton on limited global supplies and increased demand in countries such as India and China where new power stations are being built. (5/17, #15)

In Japan, regular gasoline prices climbed to a record $5.83 a U.S. gallon. Japan's falling oil demand has left it with spare refining capacity and Japanese refiners are eager to boost gasoline exports to the U.S. (5/17, #12; 5/16,#9)

In Iraq’s Kurdish sector, drillers have struck three oil fields with reserves estimated at about 2 billion barrels, Kurdish region’s Oil Minister Ashti Horami said. The escalating spat between Baghdad and the Kurdish region over deals between foreign oil companies and the regional government has led to the suspension of negotiation with two oil majors on new oil deals (5/15, #8)

A key regulatory report for the 750-mile-long, $16.2 billion Canadian Arctic gas pipeline is being delayed by several months, likely pushing the start-up date for the stalled development back again to the middle of the next decade. (5/17, #14)

Prime Minister Vladimir Putin said Russia would grant tax breaks to new oil provinces to revive output growth and add over a tenth to current output levels by 2015. (5/15, #21)

Biofuels will account for 63 percent of oil supply growth from non-OPEC countries this year, taking global production of crop-based fuel to more than 1.5 million barrels a day. Biofuel output will grow by 425,000 barrels a day this year, a 57 percent increase from a year ago, the IEA said in its monthly report. (5/14, #3)

Sudanese rebels who attacked the nation's capital Khartoum on May 10 announced that they plan to continue launching new attacks on the city aiming to destabilize the government until it falls. A second attack over the past weekend apparently failed. (5/14, #7)

The UAE is suffering from a gas supply shortage of more than one billion cubic feet per day and claims the gap can be bridged only through nuclear power and rationalization of consumption. Domestic gas demand in the UAE has grown faster than supply. (5/13, #10)

Talks between Indian conglomerate Tata and Bangladesh on a $3-billion investment stalled. Bangladesh's view that there wasn't enough natural gas for the project appeared to be behind the failure. (5/12, #13)

U.S. natural gas prices rose to the highest level since December 2005 after Enterprise Products Partners delayed restarting its Independence Trail natural gas pipeline in the Gulf to the first half of June. At full production, the pipeline supplies two percent of US natural gas and represents 10 percent of deliveries from the Gulf (5/14, #22)

Nissan will introduce an all-electric vehicle in the US and Japan in 2010 and then mass-market vehicles to consumers globally in 2012. (5/14, #25)

Senate Democrats introduced legislation to stop a US arms sale to Saudi Arabia worth $1.4 billion in a tactic supporters said was aimed at pressuring the OPEC country to increase its oil output. The Senate also rejected a Republican plan to open the Alaska wildlife refuge and some offshore waters to oil development. (5/14, #19, 20)

Emerging economies are contributing to record oil prices by subsidizing demand in their home markets as they seek to shelter their populations from the impact of crippling fuel costs, the International Energy Agency says in a new report. (5/14, #17)

Power generators with a carbon-intensive fuel portfolio are set to lose billions of Euros under the European Commission's plans for the post-2012 EU emissions trading scheme. This will accelerate the push for more gas-fired generation [moving up the timing of Europe’s problems with natural gas imports]. (5/16, #17)

Quote of the Week

“When supplies from Venezuela and Mexico were reduced to the U.S., who supplied the difference? We supplied, to the tune of an additional 300,000 barrels per day, from 1.4 to 1.7 million barrels per day, for our customers in the U.S. So how much more can we do?” — Ali al-Naimi, Saudi Arabia’s oil minister

Tom Whipple is one of the most highly respected analysts of peak oil issues in the United States. A retired 30-year CIA analyst who has been following the peak oil story since 1999, Tom is the editor of the daily …

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